For many people, the world of investments is a scary one. It seems better left to the world of big business. When one talks of investing, the image of Wall Street comes to mind. In this day and age, however, investing is not anymore for bankers and other individuals with advanced knowledge of the stock market. Everyone needs to know how to invest because the responsibility of funding one’s retirement already falls on their shoulders. Company pensions are becoming a thing of the past and experts project that Social Security benefits won’t be enough to fund a decent retirement.
As such, you should strive to understand investments and investing. There are many sources—both online and offline—that you can get to teach yourself about making your money grow. If you really want to deepen your understanding about investing, you can even enroll in finance courses in your community college.
No matter where or how you educate yourself about investing, you’ll find that one of the first and most important lessons you need to learn is that when it comes to investing, the best time to do so would be now. If you start early, time is your ally. This is because you give your investments time to grow because of the power of compound interest.
When you invest your money, it earns interest. This is how your money grows. Interest can either be simple or compound. Simple interest is interest that is computed only on the principal amount. Thus, your $100 with a monthly interest of 10 percent will grow to $110 on the first month, $120 on the second month and $130 on the third month if simple interest is used in the calculation.
Compound interest, on the other hand, refers to interest that is computed on the initial principal as well as the interest. Compared to simple interest, compound interest makes your money grow faster. Using the same example above, your $100 earning 10 percent interest compounded monthly will earn $110 on the first month, $121 on the second month and $133.1 on the third month. In compound interest, the frequency of compounding matters. The more compounding periods there are, the greater the interest, the faster your money will grow.
When it comes to investments, the power of compounding becomes even more evident. Start investing now and you get interest both on your original investments as well as the interest, dividends and capital gains. When it comes to retirement accounts, the power of compound interest is even more evident. This is because the principal can grow tax-deferred (taxes are only collected upon withdrawal) or in some cases tax-free. This means that your earnings can grow without any impediments. The earlier you start the more earnings it will accumulate.
To recapitulate, your returns on investment when the interest is compounded will be affected by the interest rate, the length of time you allow your money to be compounded and the tax rate.
Because of the returns generated by investments, it is obvious that saving money won’t be enough. You’ll need to invest if you want to have enough to fund your retirement. That being said, another lesson that you need to learn in investing is that it always entails risk. There are some investments that are riskier than others. This is why knowledge of the investment pyramid is important.
When it comes to investing, you are slated to earn higher rewards if you take on investments that have a higher degree of risk. The risk you bear is the chance that you won’t be able to get your money back in case the investment doesn’t pan out. This is known as the risk-reward concept.
With this in mind, it’s not also a good idea to invest so much money on investments that are too risky in the hope of very high returns. It is practical to diversify your investments so that you maximize returns and minimize the losses. This is where knowledge of the investment risk pyramid comes in.
The risk pyramid looks like, well, a pyramid. It has a base, a middle portion and a summit. The base represents the foundation of the pyramid and comprises the bulk of your investments. This is where your low risk investments that have a higher chance of returns are found. This includes cash and cash equivalents, government bonds or debts, money market accounts, certificates of deposits, notes and bills.
The middle part comprises investments that have higher returns than the ones on the base but are riskier. These investments, which allow capital to appreciate, include equity mutual funds, real estate, large/small cap stocks and high income bonds or debt.
The summit hosts high-risk investments and should comprise only a small portion of your investment portfolio. They have the potential to give the highest returns but also have an equal potential of making you lose your investment. As such, the amount you have here should be composed only of money you can afford to lose. The summit includes options, futures and any collectibles you may have.
This is how the investment pyramid looks like:
The investment pyramid will only serve as your guide on how you should allocate your assets. Your propensity for risk will also matter greatly on how you will treat your assets. For example, you can afford to take more risk if you plan to invest for the long-term, such as twenty or thirty years or more. This is because you have the time to allow your investment to bounce back from the bad years. However, for shorter investment periods, it is always better to be more conservative with your asset allocation.
You already know that investing is good for you and your future. However, not too many people are good at remembering to invest on a regular basis. We have a lot of other concerns that occupy our minds and push back investing to the backseat. This is the reason why it is wiser to put your investing on autopilot. This means automating your regular contributions to your investment account.
If you have signed up in your employer’s 401k plan then doing this would be easier. Most plans offer automated features that enable you to enroll, increase contributions and even rebalance your account. That means you don’t have to remember to do the investing yourself because the plan does it automatically for you. This makes saving for retirement easier and more certain, allowing for continued growth of your investments.
Don’t forget to take advantage of the auto-increase feature of your plans if it is offered. This allows you to set the percentage and frequency of the rise of your contributions so that you can maximize your earnings. Thus, if you set your contributions to increase 3 percent annually, you don’t have to remember to do it yourself but the plan will automatically do this for you, making a significant difference in your earnings amount by the time you will retire.
Don’t wait too long before you begin investing. You should get started today. If you haven’t signed up for your employer’s 401k, then it’s best to call up your human resources department and enroll. Most employers offer their counterpart up to a certain percentage of what you contribute so you are essentially getting free money to beef up your retirement savings.
If your income qualifies, try to see if you are eligible for a Roth IRA and contribute to it as well. The advantage of a Roth IRA is that the money grows tax-free and withdrawals that you make when you retire are also tax-free, making it a very useful investment account especially if you see yourself belonging to a higher tax bracket when you retire. Just like other retirement accounts, there are maximum contribution limits each year so talk with your advisor about it.
Remember that time is your greatest ally when it comes to investments. Don’t let investing wait. Start investing now!
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